Restructuring

Contributed by Ijeoma Anusionwu
A decision from a British Virgin Islands court could potentially limit efforts to recover funds for defrauded customers of the now defunct Bernard L. Madoff Investment Securities Inc. (“BLMIS”) as well as for other BVI-domiciled funds.  Irving Picard, BLMIS’s liquidating trustee, commenced a series of clawback lawsuits against customers he deemed “net winners” in Madoff’s Ponzi scheme.  One of the theories underlying many of Picard’s lawsuits – and a common theme in Ponzi scheme cases – is that amounts recovered by investors in excess of amounts they deposited are “fictitious profits” for which the investors did not provide value.  Under theories of actual and constructive fraudulent transfer, Picard has embarked on a clawback campaign against all net winners.
Fairfield Sentry Limited, domiciled in the BVI, was the largest feeder fund to BLMIS – 99 percent of Sentry’s funds were invested with BLMIS.  Thus, as a consequence of BLMIS’s collapse, Sentry also failed and is currently being liquidated in the BVI.  Borrowing from the clawback strategy adopted by Picard and other Ponzi scheme trustees and receivers, the Sentry liquidators commenced a series of clawback lawsuits in the BVI against Sentry’s investors who, prior to the liquidation, made requests to redeem some or all of their shares in exchange for the redemption price.  Notably, though, the Sentry liquidators’ claims were not based upon allegedly fraudulent activities of Sentry, but upon Sentry’s mistaken overvaluation of customers’ investments as a result of its reliance upon BLMIS’s fraudulent reports.
The Sentry liquidators argued that, because the true net asset value (“NAV”) of shareholders’ investments was nil or nominal, the liquidators had the right to recover funds disbursed to those investors who redeemed their shares prior to the discovery of Madoff’s fraud.  The liquidators based this claim on the theory of mistake of fact, induced by Madoff’s Ponzi scheme, which resulted in Sentry’s miscalculation and overvaluation of the NAV due to its redeeming shareholders.  As at the commencement of the liquidation, Sentry had already paid out hundreds of millions of dollars in response to redemption requests.  Mistake notwithstanding, the BVI court held that Sentry was precluded from clawing back funds from investors that had surrendered their shares in exchange for the redemption price.
The court reasoned that a party cannot recover payment made by mistake where said party has already received consideration from the payee.  In the court’s opinion, the redemption of shares by Sentry’s investors amounted to a bargain and sale for which the consideration received by Sentry was the surrender of all rights of the redeeming shareholders to those shares.  Furthermore, the subsequent discovery of Madoff’s Ponzi scheme did not vitiate said bargain so as to entitle Sentry to recover funds from redeeming shareholders by reason of Sentry’s mistake in computing the NAV owed to them.  In conclusion, the court stated that “it is not open to Sentry now to seek to recover the price which it paid for the purchase of the shares of redeeming investors simply because it calculated the NAV upon information which has subsequently proved unreliable for reasons unconnected with any of the redeemers.”
The court also noted that Article 11 of Sentry’s Articles of Association provides that any certificate as to the NAV per share or the redemption price given by or on behalf of Sentry’s directors in good faith shall be binding on all parties.  Under BVI law, a certificate must be in writing and signed either by or on behalf of directors.  Therefore, had Sentry also provided certificates to redeeming shareholders that reflected the erroneous NAV, the certificates would have further supported a conclusion precluding the liquidators from recovering funds from Sentry’s investors.  Finding that in this case no certificates were given to the shareholders, however, the court denied the liquidators’ recovery claims based solely on the bargain and sale theory.
This BVI judgment is preliminary and likely will be appealed.  The decision did not make a distinction between recovery of the amount invested by a shareholder and “false profits” recovered by an investor.  Moreover, as a decision based on BVI law, this ruling should not affect the viability of the clawback lawsuits brought under section 548 of the Bankruptcy Code (as opposed to section 544).  It also may be in conflict with the laws in some U.S. states, which may allow, for example, recoveries among partners in a partnership where a partner receives disproportionate recoveries.
Although BVI is one of the most popular jurisdictions in the world for International Business Companies, it remains to be seen whether the apparently greater recovery powers under U.S. bankruptcy law may make the U.S. a more popular venue for certain restructurings of offshore companies.  Notably, although the recognition of Sentry’s recent chapter 15 filing was upheld by the United States District Court for the Southern District of New York, section 1521(a)(7) of the Bankruptcy Code does not permit a foreign representative in a chapter 15 case to take advantage of the Bankruptcy Code’s avoidance powers.  For that, a foreign entity would have to commence a chapter 7 or chapter 11 case.